Greece: Catharsis or a new act in the drama?

In the last few days, the private bail-out by banks and institutional funds was welcomed as 85% of the debt was exchanged for long term debt covered by the EFSF system. If Greece is however to regain growth within the Eurozone framework, unconventional measures have to be taken by the Greek government as well as Europe.

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The bail-out was necessary to ensure that Greece would satisfy the conditions for the bail-out package provided by the Euro group and the IMF. This is the most extensive sovereign debt restructuring ever witnessed.

Bondholders are expected to lose 75% of their assets to a haircut of 53% and lower interest rates on the exchanged debt. By attaining a participation rate of 85%, Athens can force the remaining private bondholders to abide the deal and thus relieving the debt level of the country with some € 100 billion. Together with the package of € 130 billion that will be dispensed this Monday, Athens hopes to reduce its debt to 120% of GDP in 2020.

However, the assertion that Greece can reach this numbers in 2020 is an absurd misconception. Given that the periphery countries missed target after target, growth prospects had to be adjusted downwards and Greece is in a depression, it is very unlikely that Athens will bounce back swiftly towards sustainable growth.

The misguided view of the Troika

As economists, pundits and politicians all over the world debated whether austerity or fiscal stimulus would lead us out of the crisis, the IMF, the ECB and the Eurozone forced every EU country into a dogmatic austerity policy. There is much to say for cutting in excessive and unsustainable benefits and other inefficient use of public money. Europe has indeed become a fat lady that needs to trim the weight and restore competitiveness. But specifying that Keynesian economics is illegal – the new budget treaty allows only for a 0, 5 % deficit - is pushing the periphery economies into a recession post-war EU has never seen.

The premise of the doctrine that is ruling Europe now for 3 years considers savage cuts in government budgets as the solution to return to the financial markets. The negative effects of these budget cuts would be compensated by a restoration of confidence of companies and citizens and thus stimulating consumption and investment. It turned out otherwise. The enormous risks that such a blind sighted policy entails are acknowledged in a confidential IMF report.

“Moreover, there is a fundamental tension between the program objectives of reducing debt and improving competitiveness, in that the internal devaluation needed to restore Greece competitiveness will inevitably lead to a higher debt to GDP ratio in the near term. In this context, a scenario of particular concern involves internal devaluation through deeper recession (due to continued delays with structural reforms and with fiscal policy and privatization implementation).”

So what are the options Greek citizens are faced with?

Maintaining the course set out by the Troika

The fundamental problem of the current measures of the Troika is pace. Structural reforms are necessary to foster a competitive Greece. However, with an enormous competition gap and fierce rivalry of cheap eastern European countries it is unlikely that this will lead in the short term to a competitive Athens. Instead, by combining these measures with harsh budget cuts in trying to lower the current deficits, one is completely eroding private consumption and investments. The result of these measures is that Greece will never attain growth fast enough to ensure a sustainable payment of maturing debt. As a result the EU and Greece will linger from crisis to crisis with no hope for a fundamental solution.

The Troika is furthermore completely underestimating the long term effects of austerity in a country that is plagued by never seen unemployment figures. Chances are great that even if the structural reforms are embedded, Greece will not return to prosperity. The young generation, who is affected most by the austerity measures, is needed to support sustainable long-term growth but is massively looking for opportunities abroad and who can blame them? Not surprisingly young couples are choosing not to have children anymore, as a crisis without any prospects renders them hopeless and anxious about the future. In a country where the birth rate is already alarmingly low, further deterioration will put an enormous pressure on Greece’s society.

Exiting the Eurozone

In an excellent piece in The Economist, the former central bankers of Argentina and Mexico explain why an exit of the euro-zone for Greece is a destructive option and why Argentina should not be hailed as an example. First of all Greece would endure a massive bank run as people want to retreat all their current savings in euros in fear that the reinstated drachma would further devaluate their accounts. Bankruptcy of banks would be likely and given the intertwinement of the European financial system one can expect devastating effects in the whole of the Eurozone.

Abandoning the euro would leave the government and private companies into a debt spiral and lead to massive defaults since all debt would still be nominated in euro. The access to financial markets would be limited due to ever increasing debts and the lack of foreign investors that do not want to run the risk of investing in a bankrupt country. As they further argue:
“To generate confidence in the drachma in the midst of a crisis would be very challenging. Convincing potential investors to commit to projects denominated in a reintroduced currency is an almost unachievable task.”

Structural reforms backed up by European investments and solidarity

First of all the structural reforms suggested by the Troika must be implemented to ensure that Greece can become over time a competitive economy. These include tax reforms, abolishing of the overregulation in markets, opening up many professions and privatizing many public companies. But these measures should be accompanied not by austerity but by loose monetary policy and investments by other EU countries in Greece to prevent a breakdown of the economy.

The ECB must therefore be more active and become the lender of last resort for governments that cannot resort to the financial markets. The argument that it cannot play this role because of the moral hazard is hypocrite since the ECB has no problem doing it for banks, which caused the financial crisis by the excessive risk taking in the last decade. The price to pay is a little inflation in the whole of the Eurozone but given the grim economic outlook this would do no harm. On the contrary, it will decrease the debt burden of all Eurozone’s governments and would give the PIIGS countries the opportunity to keep wages constant whilst other European wages would rise, thus decreasing the competition gap.

Another measure that must be taken is investing in Greece by the other European countries. The current austerity path has proven its failure in Greece, therefore some sort of stimulus package has to be adopted. In a market where no credit is available to the government or private companies to stimulate the economy, other European countries should take over the role and temporarily strut the Greek economy by investing directly in its economy.
The current handling of the Euro crisis by the European and Greek leaders is disastrous. The first lack courage to choose a sustainable path that involves solidarity, the latter lack courage to promote structural reforms that stimulate competitiveness. The result is a deepening recession and more importantly an erosion of the community spirit across Europe. The only way out of the crisis is giving the Greeks a program of hope while strengthening European ties and solidarity.

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